Thursday, 16 October 2008 02:00

I can tell you who's holding the bag

As a continuation of the
recent posts on credit default swap risks, I am releasing my
proprietary study of Lehman's counterparties. Please read
"Interesting Lehman email" and "Do you who's going to screw who next week?" to get a clear background on the chain of posts (and the ample comments beneath the posts) that generated this one.
It would appear that I am on the right track, with extreme resources
being dedicated by already bankrupt companies to unwind trades that
were supposedly "netted out" already (Lehman Plans to Hire 200, Unwind Derivatives Trades: WSJ Link
), monolines seeking government bailouts (Ambac, Bond Insurers Will Present Plan to Tap Treasury Funds, Callen Says), and hedge funds raising substantial amounts of cash in a hostile market:

I
was very, very specific in my assertions that the hedge fund bubble has
burst, and I was even at risk of sticking my toe in the bubble since I
had my own vehicle primed and ready to go. The fund formation process
combined with my proprietary trading clued me in on the maelstrom well
before the media started running the stories. I urge all who have done
so, to please read "
In the Great Global Macro Experiment, the next bubble to burst is...". It is quite tell tale and also reveals a lot about your author. Now, back to the topic at hand.

This
CDS exposure report was a quick and dirty overnight project and thus
not perfect, for I didn't want to distract my teams from their other
projects. I will offer most of it here for free, but the actionable
items are for paying subscribers (all levels) only. I stripped out the
companies that I felt were actionable in the near term to present it to
the general blog. This the process that was used to develop a
list of companies with exposure towards Lehman's debt and equity.


We extracted data for individual companies (approx 100). Some of the
companies (in addition to the stated exposure herein) have also
disclosed expected losses or write-down on the corresponding Lehman
exposure. In cases where this information was not available we have
computed expected loss based on the recovery rate of 15 cents (US) on a
dollar.

We then used the following process to come up with a shortlist of 9 companies which may find it difficult to sustain the pressure from expected losses as a result of Lehman's failure and inability to repay.

Stage 1:

·
After computing expected loss on Lehman exposure we have computed
expected loss-to-shareholders' equity to determine the relative
magnitude of loss each company could undertake..

Stage 2:

·
In addition to expected loss-to-shareholders' equity we have also
looked into factors like absolute share price, relative decline in
share price over various periods and price-to-book value to indentify
potential companies that are prone to trouble.

· Based on the factors above we have indentified a list of 9 companies (for subscribers) which meet each of the following criteria

1. Expected loss-to-share holder's equity =>1.0%

2. Absolute share price >$15

3. Share price decline is less than 30% in last 3 months and less than 60% decline in the last 12 months

4. Price to book value more than 1.0x

Subscribers may download the actual spreadsheet here: icon Lehman Brothers CDS exposure_impact (153.5 kB 2008-10-16 19:12:02), all others can see the sanitized list below in HTML. (Update 1 -
There is a typo in this dowload. We inadvertently included price for
AMG instead of AGM. Federal Agricultural Mortgage (AGM) should go off
the list since its share price is less than $15, a criteria we used to
shortlist the companies. However, the data on exposure to Lehman ($60
bn) is correct. This makes their exposure as % of shareholders equity
to 25% (on a base of $230 bn of equity), which is significant.

It is obvious that there are still too many media types who don't read Reggie Middleton. From teh UK Telegrah: Fears of Lehman's CDS derivatives haunt markets:
It is a full week after bankers gathered in New York to start sorting
out the derivatives mess left by the bankruptcy of Lehman Brothers. We
still do not know who is on the hook for some $360bn of default
insurance, or how much they will have to pay.

Company name

Lehman exposure (US$ mn)

Expected loss

Price (Local currency)

Price US$

Exposure / Equity

Expected loss/ equity

GLG Partners Inc

$95

$81

3.8

$3.79

82.60%

70.20%

Ambac Financial Group Inc

$1,437

$1,221

1.8

$1.80

63.00%

53.60%

Friedman Billings Ramsey Group

$250

$213

0.6

$0.57

39.30%

33.40%

BlueBay Asset Management PLC

$50

$43

174.5

$3.17

35.20%

30.00%

Raiffeisen Bank Aval

$185

$158

0.3

$0.05

20.00%

17.00%

Swedbank AB

$1,378

$1,171

71.3

$10.07

14.60%

12.40%

Eaton Vance Corp

$18

$15

21.4

$21.37

7.60%

6.50%

Freddie Mac

$1,600

$1,360

1.1

$1.14

5.90%

5.10%

Petroleum Development Corp

$22

$18

21.9

$21.88

5.50%

4.60%

Straumur-Burdaras Investment Bank

$74

$63

7.1

4.70%

4.00%

American Equity Investment Life Holding

$28

$24

4.8

$4.83

4.60%

3.90%

Metropolitan Bank & Trust

$70

$14

26

$0.58

4.20%

0.80%

American Safety Insurance Holdings

$8

$8

10.7

$10.73

3.90%

3.90%

Shinsei Bank Ltd

$375

$246

206

$2.28

3.50%

2.30%

Breitburn Energy Partners LP

$50

$43

13.1

$13.13

3.50%

3.00%

Aetna Inc

$295

$251

30.6

$30.61

2.90%

2.50%

CNB Financial Corp

$2

$1

10.6

$10.62

2.90%

1.90%

PartnerRE Ltd

$110

$94

51.8

$51.82

2.50%

2.20%

Mizuho Trust & Banking Co

$108

$92

115

$1.17

2.30%

1.90%

StanCorp Financial Group Inc

$29

$25

36.2

$36.20

2.00%

1.70%

Hartford Financial Services Group Inc

$332

$282

32.8

$32.75

1.70%

1.50%

Bank of New York Mellon Corp

$477

$425

29.3

$29.25

1.60%

1.40%

First Mercury Financial Corp

$3

$3

10

$10.00

1.40%

1.20%

United Bankshares Inc

$10

$10

29.5

$29.49

1.30%

1.30%

Bank of East Asia Ltd

$54

$46

20.8

$2.85

1.30%

1.10%

Chuo Mitsui Trust Holdings Inc

$148

$49

397

$4.47

1.30%

0.40%

Montpelier Re Holdings Ltd

$19

$16

12.7

$12.66

1.10%

0.90%

Hanmi Financial Corp

$4

$4

4

$3.97

1.10%

1.10%

United Fire & Casualty Co

$8

$4

22.5

$22.48

1.00%

0.50%

Ace Ltd

$167

$150

44.4

$44.43

1.00%

0.90%

Aegon NV

$195

$166

3.9

$5.39

0.90%

0.80%

Prudential Financial Inc

$215

$183

46

$46.03

0.90%

0.80%

New York Community Bancorp Inc

$37

$31

14.5

$14.53

0.90%

0.80%

Grupo Financiero Banorte

$24

$20

22.9

$1.82

0.90%

0.70%

Harleysville Group

$6

$6

28.8

$28.78

0.80%

0.80%

Chiba Bank

$49

$42

450

$4.97

0.80%

0.70%

Great-West Lifeco Inc

$87

$74

27.8

$23.57

0.80%

0.70%

Australia & New Zealand Banking Group Ltd

$120

$102

17.3

$12.44

0.80%

0.60%

Phoenix Cos

$16

$14

6

$6.02

0.70%

0.60%

China Citic Bank Corp

$76

$65

2.7

$0.39

0.70%

0.60%

Allstate Corp

$139

$118

29.5

$29.51

0.60%

0.50%

Wachovia Corp

$494

$420

6.1

$6.06

0.60%

0.50%

Commonwealth Bank of Australia

$104

$69

42.4

$29.90

0.60%

0.40%

BOC Hong Kong

$69

$59

11.7

$1.60

0.50%

0.50%

Scor SE

$26

$22

13

$17.44

0.50%

0.50%

Wells Fargo & Co

$249

$212

33.4

$33.35

0.50%

0.40%

Unitrin Inc

$12

$10

18.1

$18.10

0.50%

0.40%

ICICI Bank Ltd

$42

$36

416.2

$8.53

0.40%

0.40%

Allianz SE

$294

$250

73.1

$102.90

0.40%

0.40%

Hua Nan Financial Holding Co

$11

$39

16.9

$0.54

0.40%

1.30%

BNP Paribas S.A

$294

$250

55.9

$80.10

0.30%

0.30%

China Construction Bank Corp

$191

$163

3.8

$0.52

0.30%

0.30%

Aozora Bank Ltd

$25

$21

105

$1.12

0.30%

0.30%

BNP Paribas

$250

$213

55.9

$80.10

0.30%

0.30%

Intesa Sanpaolo SpA

$191

$163

3

$4.43

0.20%

0.20%

Integrys Energy Group Inc

$8

$7

42.4

$42.39

0.20%

0.20%

Royal Bancshares of Pennsylvania Inc

$6

$10

4.9

$22.29

0.20%

0.30%

Cigna Corp

$10

$9

26.5

$26.50

0.20%

0.20%

Industrial & Commercial Bank of China Ltd

$151

$128

4

$0.60

0.20%

0.20%

PSB Holdings Inc

$2

$5

7.1

$22.29

0.20%

0.40%

Swiss Reinsurance Co

$44

$37

43.7

$38.63

0.20%

0.10%

Paris Re Holdings

$5

$4

11.7

$15.90

0.20%

0.10%

Banca Popolare di Milano S.C.A.R.L.

$7

$6

4.5

$6.23

0.10%

0.10%

Societe Generale SA

$58

$294

45

$65.95

0.10%

0.60%

Bank of China Ltd

$76

$64

2.6

$0.36

0.10%

0.10%

UniCredit SpA

$88

$75

2.4

$3.36

0.10%

0.10%

Industrial Bank Co

$34

$29

3.8

$0.54

0.00%

0.00%

State Bank of India

$5

$3

1540.6

$30.91

0.00%

0.00%

Credit Agricole S.A.

$15

$184

10.4

$14.89

0.00%

0.30%

Ameren Corp

$1

$1

30

$30.00

0.00%

0.00%

Swissquote Holding AG

$8

30.1

$27.23

0.00%

6.70%

Banco de Oro Unibank Inc

$79

32

$0.71

0.00%

5.80%

Rizal Commercial Banking Corp

$20

12.3

$0.27

0.00%

3.10%

Erie Indemnity Co

$19

34.7

$34.65

0.00%

1.80%

Tower Group Inc

$2

19.7

$19.70

0.00%

0.70%

Wichford PLC

$3

58

$1.00

0.00%

0.70%

FBL Financial Group

$5

16

$16.00

0.00%

0.60%

Bangkok Bank PCL

74

$2.29

0.00%

0.00%

MetLife Inc

34.2

$34.17

0.00%

0.00%

Maui Land & Pineapple

17.8

$17.80

0.00%

0.00%

Morningstar Inc

47.3

$47.31

0.00%

0.00%

Primus Guaranty Ltd.

$136

$116

0.8

$0.82

-145.50%

-123.70%

HCC Insurance Holdings Inc

None

$32

19

$19.03

1.30%

Citigroup

Minimal

16.2

$16.23

0.00%

Calamos Asset Management

Minimal

10

$10.00

0.00%

State Street Corp

no unsecured ex

46.8

$46.83

0.00%

Mega Financial Holding Co

$29

$59

10.9

$0.34

Shin Kong Financial Holding

$77

$5

7.7

$0.24

Chinatrust Financial Holding Co

$548

$465

12.5

$0.40

AXA SA

$221

$188

23.5

$23.48

Bank Hapoalim B.M.

$124

$105

2.3

$2.25

Dexia SA

$368

$258

4.8

$6.83

Friends Provident

$31

$27

13.9

$13.90

ING NV

$74

15.2

$15.18

Kingsway Financial Services Inc

$17

$14

5.8

$5.84

Matrix European Real Estate Investment Trust

$102

$86

158

$2.93

Manulife Financial Corp

$395

$336

24.2

$24.21

Mitsubishi UFJ Financial Group Inc

$312

$265

7.2

$7.20

Mitsubishi UFJ Financial Group

$235

$246

7.2

$7.20

Nicor Inc

$3

$2

28.2

$40.45

Reinsurance Group of America Inc

$32

$27

49.8

$49.75

Sun Life Financial Inc

$299

$254

26.3

$26.28

Sumitomo Mitsui Financial Group Inc

$980

$99

5.5

$5.48

UBS AG

$300

16.7

$16.66

Swiss Life Holding AG

$18

$15

PMA Capital Corp

$9

$8

Munich Re AG

$258

$219

Banca Popolare dell'Emilia Romagna

$17

$15

Commerzbank AG

Minimal

Lincoln National Corp

$121

$103

Danske Bank A/S

$100

Additional notes and comments:

Company name

Expected loss/ equity

Other information

GLG Partners Inc

70.20%

Lehman holds 13.7% stake in firm. GLG said its Lehman exposure was less than 1% of assets managed.

Ambac Financial Group Inc

53.60%

Direct
exposure to 6 interest-rate currency swaps with Lehman as counterparty:
"insignificant" net payable balance to Lehman; up to $137 million in
reinsured surety at several brokerages; about $1.3 billion in
outstanding GICs backing credit-linked notes with Lehman as counterparty

Friedman Billings Ramsey Group

33.40%

Fannie mortgage-backed security sold to Lehman under repurchase agreement

BlueBay Asset Management PLC

30.00%

Counterparty to $50 million in trades

Raiffeisen Bank Aval

17.00%

Swedbank AB

12.40%

Swedbank
decided it won't make any provision after conducting an investigation.
Swedbank is Lehman's third-largest creditor, according to a Lehman
filing.

Eaton Vance Corp

6.50%

$15.9 million debt and stock holdings through funds at Sept. 12; $2.2 million derivatives deals with non-broker-dealer lehman affiliate

Freddie Mac

5.10%

$400
million servicing-related exposure on single-family loans; $1.2 billion
unsecured Lehman payment due Sept. 15 wasn't made. Freddie Mac is still evaluating the extent of exposure to Lehman and said actual losses could exceed current estimates.

Petroleum Development Corp

4.60%

Straumur-Burdaras Investment Bank

4.00%

Lehman Brothers International Europe is a prime broker and principal. Straumur sold credit protection referencing Lehman Brothers Holding with a EUR29 million notional value.

American Equity Investment Life Holding

3.90%

1.3 million preferred stock at amortized cost; $27 million unsecured counterparty exposure. American Equity will book an other-than-temporary charge on its Lehman holdings.

Metropolitan Bank & Trust

0.80%

Extended
PHP2.4 billion loan to Lehman's Philippine Investment One Inc. and
Philippine Investment Two Inc; $20.4 million in bonds. Metrobank asked
a local court to place the units under corporate rehabilitation to stop
all claims against them. Metrobank said the loan is current. Metrobank
set aside a $14 million provision.

American Safety Insurance Holdings

3.90%

$7.7
million book value in Lehman, Fannie and Freddie investments at Sept.
30. American Safety will record a third-quarter pretax charge for the
full book value and will book a net loss because of those and other
securities-related impairments.

Shinsei Bank Ltd

2.30%

Shinsei also cut its full-year forecast to Y12 billion from Y62 billion.

Breitburn Energy Partners LP

3.00%

Counterparty to $50 million interest rate swap

Aetna Inc

2.50%

132
n in debt securities and $163 mn reinsurance recoverable from Lehman
affiliate at Aug. 31. Aetna is pursuing its claims regarding the
recoverable through liquidation proceedings. Aetna took possession of
the assets supporting the recoverable on Sept. 19.

CNB Financial Corp

1.90%

Subordinated corporate bond. Will have $1.3 million other-than-temporary noncash impairment charge.

PartnerRE Ltd

2.20%

Mizuho Trust & Banking Co

1.90%

StanCorp Financial Group Inc

1.70%

Debt securities

Hartford Financial Services Group Inc

1.50%

$91
million senior debt, $127 million subordinated debt, $34 million
preferred stock, about $50 million unsecured counterparty exposure in
connection with derivatives deals, $30 million senior debt through
credit default swaps

Bank of New York Mellon Corp

1.40%

BNY
Mellon expects to book a $425 mn third-quarter charge. Maximum $235 mn
in funds; maximum $242 mn in other capital support arrangements

First Mercury Financial Corp

1.20%

$3.18 million par value securities from Lehman, AIG and Freddie (book value $2.95 million at June 30)

United Bankshares Inc

1.30%

Senior corporate bond. Expects to record a noncash other-than-temporary impairment charge in the third quarter.

Bank of East Asia Ltd

1.10%

Chuo Mitsui Trust Holdings Inc

0.40%

Montpelier Re Holdings Ltd

0.90%

Senior debt

Hanmi Financial Corp

1.10%

Unsecured senior debt with $2.8 million carrying value at June 30; derivative contract with $1.2 million carrying value at June 30

United Fire & Casualty Co

0.50%

Ace Ltd

0.90%

$167 million aggregate par value debt in Lehman and related companies, including $75 million senior debt and $92 million subordinated debt. More than 90% of the securities are classified as "available for sale" and are marked to market.

Aegon NV

0.80%

Prudential Financial Inc

0.80%

Securities
worth $117 million amortized (fair value Sept.16 about one third that
price); debt wit fair value $8 million (down about $16 million since June 30); $90 million in unsecured counterparty derivatives exposure

New York Community Bancorp Inc

0.80%

Grupo Financiero Banorte

0.70%

$22 million senior notes, counterparty to $2 million in interest rate swaps. The exposure represents 0.07% of Banorte's total assets and 0.6% of its capital

Harleysville Group

0.80%

Unsecured notes

Chiba Bank

0.70%

Great-West Lifeco Inc

0.70%

C$101 million par value of fixed income securities

Australia & New Zealand Banking Group Ltd

0.60%

Phoenix Cos

0.60%

China Citic Bank Corp

0.60%

Allstate Corp

0.50%

$65 million estimated fair value fixed income securities at Sept. 19 (down from $185 million at June 30); $74 million net payables in counterparty exposure under master netting pacts; Lehman contributes $80 million under $1 billion credit pact

Wachovia Corp

0.50%

Evergreen
Investments' Evergreen Institutional Money Market Fund had $309 million
(1.9% of assets), Money Market Fund had $110 million (1.66% of assets),
Prime Cash Management had $75 million (0.97% of assets) invested in
Lehman credit at Sept. 12

Commonwealth Bank of Australia

0.40%

Unlikely to recover its exposure, which could hurt earnings by about A$100 mn

BOC Hong Kong

0.50%

Scor SE

0.50%

Senior notes. Scor expects "significant recoveries" on the notes.

Wells Fargo & Co

0.40%

$199
million, including $109 million in notes and $90 million in preferred
stock; $50 million in unsecured counterparty exposure; no direct lending exposure

Unitrin Inc

0.40%

Combined Lehman, AIG securities less than $12 million at June 30, 2008

ICICI Bank Ltd

0.40%

Allianz SE

0.40%

Hua Nan Financial Holding Co

1.30%

NT$370 million in bonds and bills. Hua Nan Commercial Bank booked a NT$152 million loss for its Lehman investments.

BNP Paribas S.A

0.30%

China Construction Bank Corp

0.30%

Lehman paper accounts for 0.019% of Construction Bank's assets at June 30, 2008. Exposure - $141.4 million senior

bonds and $50 million in subordinated bonds

Aozora Bank Ltd

0.30%

BNP Paribas

0.30%

According to Lehman's bankruptcy filing, BNP is owed $250 million and is one of Lehman's largest creditors.

Intesa Sanpaolo SpA

0.20%

Integrys Energy Group Inc

0.20%

Royal Bancshares of Pennsylvania Inc

0.30%

Royal Bancshares will record a $9.6 million charge related to its investments in Lehman, WaMu and two collateralized mortgage obligations $3.9 million of which relates to Lehman investments.

Cigna Corp

0.20%

Debt with book value $10 million

Industrial & Commercial Bank of China Ltd

0.20%

Lehman holdings make up 0.01% of its assets at June 30, 2008

PSB Holdings Inc

0.40%

$5.4 million pretax impairment from its Lehman and Freddie holdings, including $1.8 million from its Lehman debt.

Swiss Reinsurance Co

0.10%

Paris Re Holdings

0.10%

Paris Re's Lehman exposure represents 0.09% of its total investment portfolio.

Banca Popolare di Milano S.C.A.R.L.

0.10%

Societe Generale SA

0.60%

EUR76
million in senior debt: granted EUR3 million in loans to Lehman. SG
estimates the replacement risk for the activities in which Lehman group
companies were counterparties is around EUR400 in current market
conditions.

Bank of China Ltd

0.10%

Bonds

UniCredit SpA

0.10%

Industrial Bank Co

0.00%

Industrial Bank hasn't made any provision yet for the exposure

State Bank of India

0.00%

Expects to recover 60%-70% of its total exposure. The company has made a full provision on the securities.

Credit Agricole S.A.

0.30%

Credit Agricole expects the costs to replace Lehman collateralized market transactions to be less than EUR250 million.

Ameren Corp

0.00%

Swissquote Holding AG

6.70%

Banco de Oro Unibank Inc

5.80%

Rizal Commercial Banking Corp

3.10%

Erie Indemnity Co

1.80%

Preferred stock, bonds. Erie Indemnity expects to book a third-quarter $2.4 million charge from
its Lehman exposure, Erie Insurance Exchange anticipates a $12.2
million charge from its Lehman securities and Erie Family Life
Insurance sees booking a $4.8 million charge on its Lehman holdings.

Tower Group Inc

0.70%

Bonds. Expects to book a $2.1 mn other-than-temporary non-cash charge in 3Q

Wichford PLC

0.70%

Lehman lent GBP 344 mn. The
company said it won't have to repay more than GBP300 mn in loans. The
company cut its dividend to between 7 and 8 pence from 10.2 pence.

FBL Financial Group

0.60%

senior
subordinated bonds with $6 million amortized cost; fixed-for-floating
interest rate swap with Lehman Brothers Specialty Financing, with
estimated mark-to-market value $2.1 million payable to Lehman,
currently being terminated

Bangkok Bank PCL

0.00%

short-term bonds

MetLife Inc

0.00%

Owed $878.4 mn

Maui Land & Pineapple

0.00%

Lehman
failed to fund $35.6 million in a syndication construction loan to
Kapalua Bay Holdings LLC. Maui Land has a 51% ownership stake in
Kapalua Bay. Affiliates of Marriott International Inc. (MAR) and
Exclusive Resorts LLC and other holding members agreed to advance funds
to the venture.

Morningstar Inc

0.00%

Revenues from Lehman, Merrill and AIG was 3% of company-wide revenue in 2007.

Primus Guaranty Ltd.

-123.70%

$80 million in credit default swaps; also has CDS exposure in
bespoke tranche portfolios; has sold CDS protection to Lehman Brothers
Special Financing Inc. with mark-to-market value $56 million at Sept. 12

HCC Insurance Holdings Inc

1.30%

HCC
sold all of its positions in the preferred stock of Fannie, Freddie,
and Wachovia and in the securities of AIG and Lehman during the third
quarter. The company will realize a $19.4 million pretax loss as a
result of the sales and a net realized investment loss of $12.1 million
before taxes from all securities sales

Citigroup

0.00%

Calamos Asset Management

0.00%

State Street Corp

0.00%

Owed $1 billion

Mega Financial Holding Co

Mega
International recognized a NT$1.9 billion asset impairment loss on
investments in Lehman's commercial papers. Redemptions have cut the fund's size to NT$5 billion from more than NT$35 billion

Shin Kong Financial Holding

Booked a NT$517 million loss for its Lehman investment.

Chinatrust Financial Holding Co

AXA SA

Bank Hapoalim B.M.

Dexia SA

Senior bonds

Friends Provident

ING NV

Kingsway Financial Services Inc

fixed income

Matrix European Real Estate Investment Trust

Manulife Financial Corp

Mitsubishi UFJ Financial Group Inc

Mitsubishi UFJ Financial Group

Nicor Inc

Reinsurance Group of America Inc

Sun Life Financial Inc

Sumitomo Mitsui Financial Group Inc

SMFG expects Y10 billion in losses from credits to Lehman

UBS AG

Swiss Life Holding AG

Bonds

PMA Capital Corp

senior debt securities

Munich Re AG

Banca Popolare dell'Emilia Romagna

Commerzbank AG

Dismissed a television report that the company had EUR300 million in Lehman exposure but didn't provide specific figures for its actual exposure.

Lincoln National Corp

Danske Bank A/S

Secured deals including interest rate swaps, foreign currency and bond deals, extended facilities to Lehman units including $800 million
repo transaction with 50% nominal excess cover; Lehman guaranteed $300
million repo transaction secured by prime mortgages with 30% excess cover

Last modified on Thursday, 16 October 2008 02:00

12 comments

  • Comment Link Reggie Middleton Wednesday, 22 October 2008 23:13 posted by Reggie Middleton

    This conversation came up on the site some time ago, wherein an investor warned about the ultra short financials after someone was crowing about the banks going bankrupt/into conservatorship/etc. He lamented that for every bank that goes completely out of business, the available payout to the ultrashort fund is reduces by X amount due to the fact that they are using swaps to gain exposure versus directly shorting or option. I, personally, don't touch ETF's since I desire more control and granularity in my positions, not to mention transparency. Hence, my knowledge on the topic is limited. I can't vouch for the veracity of the statement above, but look at it this way, each of the swaps powering the ultra shorts needs a counterparty. How viable is that counterparty, and exactly what is written in the swap agreements. Will the ETF manager be able to unwind those swaps when the time comes. This is why I don't use swaps either. The deeper in the money they are, the less likely you will find the liquidity to unwind them quickly and easily. You don't need government intervention for those ultra ETF situations to blow up on you.

    I welcome anyone with experience or knowledge in/of these topics to chime in.

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  • Comment Link sdmtgbanker Wednesday, 22 October 2008 22:58 posted by sdmtgbanker

    Reggie,

    Just found your site recently and must say I am very impressed with the content and analytics.

    I am most concerned with the "Dark Cloud" of derivatives and other MIT engineered financial timebombs laying wait for us out in the market. Wanted your thoughts on a theory that I am kicking around about a potential "HUGE" curveball that could possible come out of left field and dessimate a wide swath of both institutional as well as retail investors in the Ultra ETF's.

    I had been investing in Ultra short ETF's (SRS, SKF, SMN) up until this week. Over the weekend I noticed a possible arbitrage opportunity if I shorted the Ultra Long and the corresponding Ultra Short fund at the same time (URE/SRS, UYG/SKF, UYM/SMN) as there seems to be a 3% - 8% difference in their movements over time in favor of the the long funds. Upon doing more research on their holdings, I was shocked to learn that their holdings are almost exclusively swaps and derivatives. Therefore, I'm afraid that their business model may be in jeopardy if the gov't changes the rules on derivatives written ,where the institution receiving the protection does not own the underlying security or their is a counterparty default in the CDS market.

    Therefore, to be safe I have changed to only shorting the Ultra long funds for now, but may add the arbitrage of shorting the Ultra shorts as well in the future if we get a serious counterparty default in any of the upcoming CDS auctions. These funds are built on the same "Financially Engineered" products that are at the heart of this whole mess, and are not stress tested.

    May be an outside shot..... but if counterparty risk escalates, these "Ultra" funds (Long and Short) could both fail.

    I may be missing something here, your thoughts would be greatly appreciated.

    Thx

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  • Comment Link Knute Rife Saturday, 18 October 2008 23:18 posted by Knute Rife

    ...the hedges are [i]not[/i] defective in today's economics. All these instruments depend on an accurate initial assessment of risk, and I have yet to see a CDS that could not have been more accurately valued initially by using a dartboard. There are reasons insurance policies are not treated like securities, and the CDSes are bringing those reasons home with a vengeance.

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  • Comment Link Brian Nurick Saturday, 18 October 2008 20:35 posted by Brian Nurick

    If the GIC is a Repo, then it terminates at par and AMBAC would actually make money in today's market when the hedges are undone. For a Forward Delivery Agreement, which terminates at market, it is what it is. I could see on the Repo where they terminate at par you would assume the hedges are "in the money" and AMBAC would actually make money in today's economics, however, if the hedges are defective, they lose as they are worthless and they still have to pay out at par...

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  • Comment Link Toro Saturday, 18 October 2008 20:19 posted by Toro

    Reggie,
    According to the Ambac press release:
    http://www.ambac.com/Press/091608.html
    "Ambac’s Financial Services business has approximately $1.3 billion in outstanding GICs backing Credit Linked Notes where Lehman is the CDS counterparty to the transaction.
    A Failure to Pay or Bankruptcy by Lehman could result in an Event of Default in these transactions, an early termination of the GIC and a return of the deposited monies at par."

    You seem to be implying that Lehman's bankruptcy will force Ambac to pay-out 100% under the GIC's.
    This does not seem to jive with the press release which says monies will be returned at par. What am I missing as my take from this is that Ambac's exposure to Lehman is minimal.

    The main risk to Ambac of course is the downgrade by moody's etc. which would force it to post collateral - but not Lehman.

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  • Comment Link Brian Nurick Saturday, 18 October 2008 08:40 posted by Brian Nurick

    Reggie: Would it not make sense to do the same for the Washington Mutual sale coming? In looking at the data, it seems on some of the stocks, these loses might be already taken into account... Thanks. BN

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  • Comment Link Reggie Middleton Friday, 17 October 2008 18:48 posted by Reggie Middleton

    This is a very interesting article on Roubini's site that strikes up a conversation very similar to the one's on this site. Recommended reading: [url]http://www.rgemonitor.com/economonitor-monitor/254052/lehman_cds_payout_on_october_21_360bn_or_6bn[/url] - be sure to read the comments

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  • Comment Link Truth08 Friday, 17 October 2008 14:02 posted by Truth08

    Karl Denninger has a good post on the CDS market and Lehman exposure, as well as the bailout. The level of fraud and corruption in all this makes me sick. I'm linking to his post through my blog because I could use the traffic :'(
    [url]http://www.thetruthshallsetyoufree.net/?p=44[/url]

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  • Comment Link Daniel Benyam Friday, 17 October 2008 01:27 posted by Daniel Benyam

    Great job with this analysis. Its your world right now and you keep crushing it.

    I'm surprised anyone would be long equities with this type of risk still in the financial system. People either dont learn, or have very short memory.

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  • Comment Link I Irongate Friday, 17 October 2008 01:16 posted by I Irongate

    Sh*t man..... I have NEVER gotten such value for the dollar when paying for research. Invaluable is all i can say

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  • Comment Link Reggie Middleton Thursday, 16 October 2008 23:09 posted by Reggie Middleton

    [url=http://www.stockhouse.com/tools/?page=/FinancialTools/sn_newsreleases.asp?symbol=T.III&newsid=7081552&apFlag=]Imperial Reports on Commodity Hedges with Lehman Brothers[/url]
    [quote]Imperial Metals Corporation (TSX: III) reports that a portion of its commodity hedges are with Lehman Brothers Commodity Services Inc. ("LBCS"), a subsidiary of Lehman Brothers Holdings Inc. ("Lehman"). Both Lehman and LBCS have filed for bankruptcy protection.

    The contracts with LBCS represent approximately 20% of the pounds of copper that Imperial has hedged at October 14, 2008. The put contracts with LBCS, all for settlement in 2009, cover a total of 14,550,000 pounds of copper at a weighted average strike price of US$3.05 per pound of copper. [/quote]

    As hedges fall apart, balance sheets get re-adjusted. Once the right hedge is broken, it can cause a domino effect all the way down the line. I am aware that many who are in the industry may not be able to see the risk because they are too close to it. I have an advantage because I approach it with a fresh, maybe even naive outlook.

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  • Comment Link Mark Hankins Thursday, 16 October 2008 20:39 posted by Mark Hankins

    Hedge funds are for grown ups, and grown ups shouldn't cry (and nobody should cry for them either). If anybody who invested in a hedge fund finds himself eating at Golden Corral instead of Ruth's Chris, well, them's the breaks. Could be worse. Could be McDonalds, where I eat.

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